This site uses cookies to store information on your computer. Some are essential to make our site work; others help us improve the user experience. By using the site, you consent to the placement of these cookies. Read our privacy policy to learn more.

The economic substance doctrine is a common law judicial
doctrine that disallows tax benefits of a transaction if the
transaction lacks economic substance or a business purpose.
The doctrine was codified in 2010 in Sec. 7701(o), which
defines a transaction as having economic substance if (1)
the transaction changes in a meaningful way (apart from its
federal income tax effects) the taxpayer's economic
position; and (2) the taxpayer has a substantial purpose
(apart from those tax effects) for entering into the
transaction.

In the notice, the IRS states that for purposes of
determining whether the codified economic substance doctrine
applies, a transaction generally includes all the factual
elements relevant to the expected tax treatment of any
investment, entity, plan, or arrangement; and any or all of
the steps that are carried out as part of a plan. Facts and
circumstances determine whether a plan's steps are
aggregated or disaggregated when defining a transaction.

When a plan that generated a tax benefit has
interconnected steps with a common objective, the IRS will
define "transaction" as including all of the steps
together in aggregate. Every step will be considered when
analyzing whether the transaction as a whole lacks economic
substance. If a series of steps includes a tax-motivated
step that is unnecessary to achieve a nontax objective, the
IRS will disaggregate the transactions.

Sec. 6662(b)(6) imposes a penalty on an underpayment
attributable to tax benefits that were disallowed because a
transaction lacks economic substance under Sec. 7701(o) or
fails to meet the requirements of any similar rule of law.
According to the IRS, "similar rule of law" means
a rule or doctrine that applies the same factors and
analysis as under Sec. 7701(o) for an economic substance
analysis, even if a different term (e.g., "sham
transaction doctrine") is used to describe the rule or
doctrine.

However, the IRS considers Code sections and Treasury
regulations, other than Sec. 7701(o) and the regulations
under that section, that disallow tax benefits to not be
similar rules of law for purposes of Sec. 6662(b)(6).
Therefore, the IRS will not apply a penalty under Sec.
6662(b)(6) (or otherwise argue that a transaction is
described in Sec. 6662(b)(6)) unless it also raises Sec.
7701(o) to support the underlying adjustments.

These rules apply to transactions entered into after
March 30, 2010, the date Sec. 7701(o) was
enacted.

Among CPA tax preparers, tax return preparation software generates often extensive and ardent discussion. To get through the rigors of tax season, they depend on their tax preparation software. Here’s how they rate the leading professional products.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.